Greece: this way out (of the crisis)?

While Greece came close to exiting the eurozone (Grexit) in summer 2015, its exit from the third bailout programme, planned for this summer, is now the main challenge facing the country and its creditors (the European Stability Mechanism, the ECB and the IMF). The latter will have to agree on a credible post-programme surveillance framework to ensure that exiting the programme means exiting the crisis.

For the first time since the 2007 subprime crisis, Greece’s economic growth is expected to have exceeded 1% in 2017, following a relative stagnation since 2014 and a recession averaging 5% a year from 2008 to 2013. This meagre recovery has been fuelled by household consumption, with unemployment gradually falling [1] to 20% at end 2017, after peaking at 28% in 2013, in spite of wages declining steadily since 2010 (they have fallen to three quarters of their pre-crisis levels). Greece has been through a violent adjustment, which put a sharp squeeze on domestic demand before boosting the country’s competitiveness. The country’s current account has been more or less balanced since 2015, and Greece is now benefiting from stronger economic activity in the eurozone. Exports – substantially buoyed by tourism – should continue to make a positive contribution to growth, though the recovery will continue to depend mainly on domestic demand, which is beginning to benefit from an upturn in investment – the first since 2007.

The investment ratio, which is desperately low – ten percentage points below its pre-crisis level – will be a key component in ensuring robust growth over the next few years. However, investment remains highly volatile, since it depends on a sustainable recovery in investor confidence in the Greek economy and the country’s banking sector. Meanwhile, non-performing loans continue to account for over one third of total lending, and banks have yet to recover the amount of deposits withdrawn [2] in 2015, during the trial of strength between the newly elected government and the country’s creditors. With the third [3] adjustment programme due to end on 20 August 2018, Greece is going to have to convince investors that its economy can finance itself without financial life support from Europe: this is the key to Greece’s successfully exiting the bailout programme and its creditors coming up with credible post-programme surveillance (PPS) arrangements.

Indeed, the third bailout programme marks the point when Greece’s executive resigned themselves to the demands of the country’s European creditors. As tensions between Greece and its creditors reached their peak following the ‘no’ vote in the 5 July 2015 referendum on the terms of the third bailout, current prime minister Alexis Tsipras, of the far-left Syriza party, finally agreed to stop playing the dangerous Grexit card and continue with the fiscal adjustment demanded by the country’s creditors. The latter did not hesitate to up the ante, adding an automatic budget cut mechanism to ensure that Greece would meet the ambitious target of a primary budget surplus [4] of 3.5% of GDP from 2018 to 2022.

Greece has had a primary surplus since 2014, in spite of three bank recapitalisation plans averaging over 4% of GDP between 2012 and 2015. This adjustment has been effected by freezing current primary expenditure [5], but above all by steadily improving receipts, including in particular the tax take. The introduction of capital controls to stem deposit flight in June 2015 also appears to have encouraged part of the grey economy back into the light.

Greece now appears able to generate a substantial primary surplus, and thus to rebuild a sufficient cash buffer to meet its funding needs for the next year, and maybe even until the end of 2020, if the Eurogroup decides to leave at its disposal, as part of the PPS, the unspent third of the €86 billion third bailout, in case the country runs into refinancing pressures. Furthermore, thanks to concessional loans from the ESM and debt relief measures already adopted, the apparent interest rate on Greece’s debt should be able to be contained at 2% over the next five years – well below the nominal growth rate, thus allowing the debt ratio to fall from its current level of 180% to around 150% of GDP by 2030. It is on the basis of this ten-year sustainability of Greece’s debt that rating agencies S&P and Fitch have upgraded the country’s credit rating [6] by several notches since 2015. Combined with the low interest rate environment favoured by the ECB, this enabled ten-year sovereign yields to fall back below 5% by end 2017.

However, while the consensus is that Greece’s debt will continue to decline until 2030, the IMF continues to assert that beyond that date, the debt trajectory will once again become unsustainable, as the effects of concessional interest rates and grace periods granted by public creditors are offset by a preponderance of debt at market rates. The IMF does not believe Greece can generate a long-term primary surplus of more than 1.5% of GDP or long-term nominal growth of over 1.8%; as such, its Debt Sustainability Analysis (DSA) shows that the country cannot sustain such a rise in interest rates. This is why the fund refused to take part in the third bailout without a more significant debt reduction by European creditors; it is encouraging the latter to formally commit to all debt relief measures (extending grace periods and maturities and subsidising interest rates) presented to the Eurogroup in May 2016.

Northern eurozone countries are currently balking at such concessions so as to maintain a degree of pressure on the Greek executive throughout the duration of PPS, which will continue to run until 75% of European aid has been repaid (potentially not until 2050). A mechanism for automatically cutting the country’s debt if it goes into recession is under consideration, but there is no guarantee this will be enough to convince the IMF. One thing is certain: Greece will never be able to return to robust growth unless the Gordian knot of debt sustainability is untied.

Léopold JOUVEN

[1] To put this fall in unemployment into its proper perspective, employment has risen 8% since 2013, while the working population has held steady after declining by 4% between 2009 and 2013.

[2] Deposits are currently one quarter lower than 2014 levels and one third below their 2009 peak.

[3] Under the first two bailout packages, Greece received total aid of €73 billion and €154 billion between 2010 and 2015. Syriza’s rise to power in January 2015, and its refusal to continue to implement the fiscal austerity on which European assistance depended, meant payments were interrupted from August 2014 until the emergency third bailout programme in August 2015.

[4] Government budget balance excluding interest expenses: by comparison, the eurozone’s primary surplus should remain close to 1% of GDP for the next few years.

[5] Excluding interest costs and bank recapitalisation.

[6] Furthermore, the rating agencies have stipulated that any reduction in or restructuring of off-market debt (i.e. owed to European public creditors) will not be considered an event of default, and would even have a positive effect on the country’s credit rating.